Gov. Reynolds can make history by dumping tax deduction

On the heels of the new federal tax reform law, Gov. Kim Reynolds said that Iowa's own tax system needs to be changed in order to provide tax relief during her first Condition of the State address.
Brian Powers/The Register

Federal deductibility has hurt Iowa for decades

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Gov. Kim Reynolds address the Iowa Legislature during her first Condition of the State address on Tuesday, Jan. 9, 2018, in Des Moines.(Photo: Brian Powers/The Register)Buy Photo

Good luck, Gov. Reynolds. May you accomplish what your predecessors failed to do: Get rid of Iowans’ ability to deduct federal tax payments from their state income taxes.

Terry Branstad proposed eliminating “federal deductibility” in the 1980s and gave up. Tom Vilsack and Chet Culver also pushed it to no avail. All of them faced fierce opposition from anti-tax and pro-business groups who portrayed it as a “tax on a tax.”

But this year, Reynolds has a grand opportunity because her party passed federal tax cuts in Congress.

The new federal cuts add urgency to the issue, but federal deductibility has hurt Iowa for decades, costing billions in revenues. The Iowa deduction began in 1934, but it was initially limited. It wasn’t expanded to a full deduction of federal taxes until 1955.

In a 2010 study, the value of that provision was estimated at $574.8 million; it was the third-largest expenditure in the tax code.

Iowa is one of only three states that allow this exemption in full. As a result, it tends to make Iowa’s tax rates appear less competitive compared to those in most states.

And as the governor noted, “it often punishes those who we want to help the most.” In other words, federal deductibility offers little or no break to low- or middle-income families. A study from 2009 showed that middle-income taxpayers in Iowa pay a higher percentage of their income in taxes than the richest because of federal deductibility.

Even fans of trickle-down economics can’t defend an income tax code that gives the lowest rates to the wealthiest.

CLOSE

Iowa lawmakers, both Republicans and Democrats, react to Gov. Kim Reynolds' proposals for tax reform in her Condition of the State address on Tuesday, Jan. 9, 2018.

Let’s not pretend Reynolds’ act is an example of political courage. If the Trump tax cuts wouldn’t have passed, would the governor be so eager to embrace an idea long championed by Democrats? And remember that her main Republican opponent in the governor’s race, Ron Corbett, already called for ending the deduction.

But it’s also true that Reynolds' position was evolving before the federal tax cuts were introduced.

When she took office in May, Reynolds wasn’t ready to commit to eliminating federal deductibility, but she was clearly emboldened to stand up to anti-tax organizations.

More business groups have come around to the idea of eliminating the deduction, too. In 2009, when Gov. Culver and Democrats proposed eliminating it, one of the opponents was the Iowa Chamber Alliance and its executive director, Dave Roederer. He’s now the director of the Department of Management and Reynolds’ top budget guy.

Many business groups, including the Iowa Chamber Alliance, want to pair ending federal deductibility with a "restructuring" of rates, such as a lower tax rate for corporations.

Not yet, Reynolds said on Tuesday: “… we have to focus on what we can afford. While I want to reduce our uncompetitive corporate taxes, this is not the year.”

Reynolds could also face opposition from lawmakers in her own party. An internal memo prepared for Iowa Senate Republicans late last year, before the federal tax cuts passed, contained some details at how lawmakers could proceed. The draft proposed eliminating federal deductibility for corporations in tax year 2022, but retaining it for individuals.

That idea makes little sense now, if it ever did. Republican lawmakers should get on board with the governor’s idea. They can help her make history and achieve what no Iowa governor, Republican or Democrat, has accomplished.